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Journal of Modern Accounting and Auditing, ISSN 1548-6583December 2013, Vol. 9, No. 12, 1564-1573

Audit Quality in Practice: A Critical Analysis of the Financial

Reporting Council (FRC) Discussion Paper

Noor Adwa Sulaiman, Mazni Abdullah, Kamisah Ismail, Noor Sharoja Sapiei

University of Malaya, Kuala Lumpur, Malaysia

The efforts by the Financial Reporting Council (FRC) in the United Kingdom (UK) to stimulate audit firms to

improve audit quality manifest in its Discussion Paper: Promoting Audit Quality warrant further analysis. The

discussion paper identified factors such as audit firm culture, the quality of people, the effectiveness of audit

process, and outside factors such as management and audit committee (AC) which can affect level of audit quality

in practice. Reporting upon the analysis of responses to the discussion paper, the objective of this study is to

analyze views from the respondents about various issues related to audit quality. This study composes of how

subject of audit quality is seen in practice, which contributes to our understanding of conditions, events, or

processes that can affect audit quality in practice.

Keywords: audit quality, content analysis, regulation, United Kingdom (UK)

Introduction

The efforts to motivate audit firms to improve quality of their services underlying standard-setting

activities and doubts about the quality of audit have motivated investigations and other actions by regulators(Panel on Audit Effectiveness, 2000; International Auditing and Assurance Standards Board [IAASB], 2011).

In an effort to restore trust and confidence in the audit profession and capital market, various changes to the

regulatory regime for auditing and governance practices have been made in the United States (US) and in other

jurisdictions including the United Kingdom (UK) and the European Union (EU). In addition, in the process of

regulatory change to enhance audit quality through various initiatives and projects, public discussion has

become a regular aspect to legitimize regulator activities (Financial Reporting Council [FRC], 2006; European

Commission [EC], 2010).

This paper analyzes responses to the Discussion Paper: Promoting Audit Quality issued by the FRC which

took place in 2006. The consultation paper aims to seek views from all interested parties in the audit process

about factors that influence audit quality in practice. There are two primary aims of this paper: (1) to developthe understanding of how concept of audit quality is understood by respondents as expressed in their

Noor Adwa Sulaiman, Ph.D., lecturer, Department of Accounting, Faculty of Business and Accountancy, University of Malaya.Mazni Abdullah, Ph.D., senior lecturer, Department of Accounting, Faculty of Business and Accountancy, University of

Malaya.Kamisah Ismail, Ph.D., senior lecturer, Department of Accounting, Faculty of Business and Accountancy, University of Malaya.

Noor Sharoja Sapiei, senior lecturer, Department of Accounting, Faculty of Business and Accountancy, University of Malaya.Correspondence concerning this article should be addressed to Noor Adwa Sulaiman, Department of Accounting,

Faculty of Business and Accountancy, University of Malaya, Kuala Lumpur 50603, Malaysia. Email: [email protected].: +603-7967 3856. Fax: +603-7967 3980.

DAVI D PUBLISHING

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AUDIT QUALITY IN PRACTICE: A CRITICAL ANALYSIS OF THE FRC DISCUSSION PAPER 1565

submission; and (2) to consider factors which respondents consider to have an influence on the attainment of

high audit quality in practice.

This study enhances the understanding of the nature of audit quality from the practical perspective of those

responded to the discussion paper that is also drawn from the context of auditing within the UK. Whereas much

of the prior research has been dominated by studies conducted with reference to the US environment, the

authors adopt a large-scale market-based approach or survey-based approach to investigate the association

between some “input” and “output” measures of audit quality (Watkins, Hillison, & Morecroft, 2004; Francis,

2004; Humphrey, 2008). Therefore, an important motivation for this study was a concern to go beyond existing

approaches to audit quality. This study attempts to contribute to the understanding and knowledge of audit

quality by researching this issue within the context of regulation of audit quality. In addition, assessing views of

responses to the discussion paper contributes to the growing literature on regulation and its potential impact on

audit quality or audit practice.

The remainder of this paper is organized in five sections. Section two provides a review of relevant

literature. Section three describes the research methods used in the study. Section four explains discussion andinterpretation of findings. Finally, section five ends with conclusions of the study.

Audit Quality

The concept of audit quality has proved difficult to define with certainty. It is not immediately or directly

observable and is difficult to measure (Power, 1997). Moreover, audit markets’ participants have conflicting

roles and different expectations that lead to different interpretations of audit quality (Sutton, 1993). As a result,

different people tend to have different definitions and ways of measuring it (Rasmussen & Jensen, 1998;

Watkins et al., 2004), which suggests ambiguity and subjectivity in the term audit quality.

The regulator in the UK and professional practitioners have never defined the term precisely, although

various initiatives have been built around the term and serve to influence contemporary understandings of suchconcepts (Institute of Chartered Accountants in England and Wales [ICAEW], 2002; FRC, 2007). The

professional literature is inclined to define audit quality in relation to meeting the requirements of the auditing

standards during the course of the audit (Krishnan & Schauer, 2001; McConnell & Banks, 1998).

In comparison, various academic research approaches that are relevant to audit quality have defined and

measured audit quality in a number of ways, involving a combination of measures that linked inputs (such as

industry expertise, the amount of non-audit services, and tenure and size of the audit firm) to audit outcomes,

such as audit failures (Feroz, Park, & Pastena, 1991) and the quality of financial reporting (Becker, Defond,

Jiambalvo, & Subramanyam, 1998; Gul, Sun, & Judy, 2003), process measures that are related to auditor

performance (such as audit procedures, judgment and decision-making, and quality-threatening behavior)(Sutton, 1993; Malone & Roberts, 1996), and to capture quality attributes of relevance to users and preparers of

financial statements (Carcello, Hermanson, & McGrath, 1992; Duff, 2009).

Overall, research on audit quality shows various concepts attached to audit quality. Nonetheless, there is

limited research that examines the impact of contextual factors (people, processes, and audit environment such

as the role of regulation, audit committee (AC) members, and audit clients) on attainment of high audit quality

in practice (FRC, 2006; IAASB, 2011). This research aims to add to understanding of this issue by

investigating widely-held views of interested people on various issues of audit quality published in the

discussion paper.



AUDIT QUALITY IN PRACTICE: A CRITICAL ANALYSIS OF THE FRC DISCUSSION PAPER1566

Research Method

The FRC published a discussion paper on promoting audit quality and sought answers to 17 specific

questions that relate to five main drivers of audit quality:

(1) Culture within an audit firm;(2) Skills and personal qualities of audit partners and staff;

(3) Effectiveness of audit process;

(4) Reliability and usefulness of audit reporting;

(5) Outside factors beyond the control of auditors that affect audit quality, such as the approach taken by

management and the contribution made by the AC.

The structured nature of the discussion paper with its 17 questions determined, in most cases, the structure

and content of the responses received. Nonetheless, respondents are not obliged to structure their answers in a

particular way, and any very strong feelings about the issues under review would likely to emerge regardless of

the structure. As such, the respondents made a significant number of additional comments in their covering

letters.

Respondents and Content Analysis

Thirty nine sets of responses were received in response to the discussion paper (see Table 1). Although the

self-selected sample provides some limitation of the study, nonetheless analysis of responses to the discussion

paper offers an opportunity to access the views of a wide group of interested parties and thus to develop a richer

insight into varying perspectives on audit quality. This paper is based on the content analysis of the comments

received by the FRC. Content analysis refers to quantify text for recurring words or phrases, or themes (Patton,

2002; Berg, 2006). In analyzing the comments, a set of themes or categories were developed from the data and

were then counted and reviewed to ensure that all of the issues had been identified.

Table 1

Respondents to the Discussion PaperRespondent Number of responsesAudit firmsProfessional bodiesInvestorsCorporate respondentsOthers

811

82

10

Discussion and Interpretation of Findings

This section provides findings of the study. Table 2 provides a summary of the significant aspects of the

detailed analysis.

Audit Firm Culture

In general, respondents agreed that the culture of the audit firm was an important driver for audit quality.

Auditors, investors, professional bodies, and companies all made similar comments on this point. They viewed

the indicators identified by the FRC, such as leadership, auditing and ethical standards, promotion of

consultation, partner and staff development systems, and information infrastructure as essential to achieve

high-quality audits. A professional body, the ICAEW, emphasized the significance of good technical support

and the culture of leadership throughout the audit firm that drives audit quality.




Table 2

Key Issues of the Comments

Respondent Audit firm Professional body Investor Corporate

respondent Other

Total number of respondents 8 10 9 2 10The culture of the audit firmConcern about tick-box mentality culture 5 4 0 1 1Concern about focus on documentation 4 2 0 0 0Concern about commercialization of the audit firm 0 0 3 0 1Suggest professionalism as part of culture of the audit firm 0 0 4 0 0Sought greater information about governance and control of the auditfirm

0 2 7 0 1

The quality of peopleDiverse and up-to-date skills and knowledge 8 5 7 1 5Concern about attractiveness of the profession 7 1 2 0 1Concern about availability of audit staff 7 5 0 0 0

No fundamental review of the qualification and training requirements 4 5 3 0 0Concern about requirement of partner rotation 3 1 0 0 0The effectiveness of the audit processConcern about overly complex audit standards and regulations 7 6 1 1 3Concern about move to prescriptive audit approach 7 5 3 2 2Regulators should promote and enhance principles-based auditapproach

5 6 2 2 0

Important role of audit client to audit process 7 6 5 1 2Important role of AC to audit process 7 6 4 1 1The reliability and usefulness of audit reportReputation of audit firm and audit profession 2 3 1 1 1Greater information from audit firm 2 1 5 0 1

Understand ability of audit report 1 2 5 0 1Other factors affecting audit qualityImportant role and support of the management 7 2 0 0 0Important role and responsibilities of AC 7 6 7 1 1AC discharging adequate responsibilities 4 1 3 1 1Sought detailed guidance for AC to evaluate effectiveness of audit 3 3 2 1 4Sought summary of work of AC in annual reports 7 4 1 0 5Other issuesWelcomes references to discussion paper 8 10 8 2 6Concern about lack of empirical evidence to support some of theassertions

3 3 5 0 0

Insufficient attention to other critical dimensions of audit quality 6 4 1 1 0

Resource concern 5 5 1 1 1Concept or definition of audit quality requires clarification 0 1 0 1 0

While accepting the importance of culture to audit quality, most of the audit firm respondents were keen to

describe concerns and problems about the changing culture in the audit firm created by the current regulatory

framework. Eleven respondents claimed that the changes have diverted audit firms’ attention from the

principles to rule-based procedures that could create a culture of a “tick-box” or compliance approach in audit.

The compliance approach has also created an excessive focus on documentation that could reduce the use of

knowledge and professional judgment in the conduct of the audit. The respondents argued that the prescriptive




approach was restricting the auditor’s ability to exercise professional judgment and shifting the nature of the

audit to compliance work, thereby affecting the quality culture of the audit firms and impacting the

effectiveness of the audit process. These eventually would undermine the quality of the audit.

In comparison, it was frequently claimed by a number of investor respondents that commercial interests

have become a major aspect of the culture of the audit firms and could compromise the audit quality. The

investors voiced concern about the commercial objectives of the audit firms that could create a threat to audit

quality. Further, they suggested that the audit firms should promote and encourage culture of

professionalism an audit that serves the public interest for the benefits of shareholders and other users of theaccounts as part of the indicators of their quality culture. Eight respondents advocated that greater information

about quality initiatives and the governance and control of the audit firms could enhance their confidence in the

quality culture of the audit firm. In general, the respondents highlighted the lack of information about the audit

firm’s policies and actions that they take to embed a culture of quality within the firm.

Overall, the majority of the respondents agreed that culture is imperative and will influence the quality of

audit practice. The user group representative, that is, the investors mentioned a great concern on culture ofcommercialization of audit firms that could undermine audit quality. The audit firms and professional

associations pay attention to the negative effect of the audit regulation on the culture of the audit firms.

Identification of culture as one of the key drivers of audit quality may indicate considerable concerns for the

regulator concerning “commercialized professionalism” that promotes a culture of client-centered services

(Hanlon, 1994) that may be viewed as detrimental to audit quality. As the Audit Inspection Unit (AIU, 2006)

pointed out, commercial considerations and measures continued to be a driver of performance measurement in

the audit firms rather than audit quality. The investor respondents in this study voiced concern regarding the

commercial business approach of the audit firms that had contributed to a decline in audit quality in recent

years. In like manner, some prior research has shown that deterioration of the culture of professionalism causes

conflicts in values and practices within the audit profession that affect audit performance (Wyatt, 2004; Baker,

2008). Recent corporate scandals have raised the question whether accounting firms have nurtured cultures that

emphasize an appropriate level of professionalism and commitment to serving the public interest (Jenkins,

Deis, Bedard, & Curtis, 2008).

The Quality of People

Almost all of the respondents fully agreed with the importance of the auditor’s knowledge, skills, and

personal qualities of the audit personnel for attainment of high audit quality. Investors, auditors, companies,

and professional bodies all made similar observations on this point. For example, the investors pointed out the

necessity for auditors to keep their technical skills up to date with the changes in the business environment.

Likewise, a professional body respondent believes that technical skills, personal qualities, professionalskepticism, and practical experience are key drivers of audit quality.

The audit firm respondents asserted that it is important for the auditors to have diverse and up-to-date

skills and sufficient experience. These attributes are important in supporting professional judgments and an

effective audit process during the conduct of the audit. As such, the audit firm respondents emphasized the

importance of academic qualification, entry and selection requirements, and training procedures in the audit

firm to advance the knowledge and skills of auditors to achieve high audit quality: quality audit judgment. The

audit firms and the professional bodies frequently stressed points concerning the potential adverse impact of the




current regulatory environment on the quality of people in the audit firm. They argued that excessive regulation

resulted in changing the nature of audit work to a more compliance-based activity. It also had an unfavorable

impact on the attractiveness of the profession to hire and retain quality audit staff: “There are concerns that the

attractiveness is being impacted by regulators that place too much emphasis on the application of the rule rather

than principles” (Klynveld Peat Marwick Goerdeler [KPMG], 2007, p. 3).

Overall, the majority of the respondents in this area support the importance of quality of people to audit

quality. Nonetheless, analysis of the responses shows that respondents were inclined to highlight concern with

unfavorable impact of current regulatory environment to expertise and judgments of the auditors. While

accepting potential negative impacts of the changes in audit regulation on the quality of people, the responses

provided by the audit firms and professional bodies can also be seen as an important defense against the

imposition of more prescriptive regulations that may be detrimental to market dominance, social status, and

jurisdiction of their work. Analysis of responses also shows that there is a considerable tension around regulation

and concern of the audit firms concerning further regulation that might be proposed as a result of the debate

around the discussion paper. Given this context, responses from audit firms on this issue can be viewed as anobjection towards development in the audit regulation and eventual independent oversight and direct regulation

of the audit profession. As such, an emphasis on expertise and professional judgment is entirely to be expected,

as it reflects an aspect of firms’ self-interest. Attributes of professional claims to special knowledge and expertise

are necessary to sustain and legitimate professional status and the related social and economic rewards

(Richardson, 1987). For this reason, professionalism often involves a traditional stance against regulation.

The Effectiveness of the Audit Process

The FRC asserts that factors such as characteristics of the audit team, technical support, audit

methodology, auditing standards, and quality control procedures contribute to the effectiveness of the audit

process. Analysis of the responses shows that the respondents were fully in accord with the assertions. Themajority of the respondents also emphasized the important role of the audit client and ACs for an effective audit

process. Other factors that influence the effectiveness of the audit process include application of business risk

audit approach in an audit and experience of the audit partners. Eighteen respondents expressed deep concern

about the effect of excessive complex standards and regulation that shift auditing from principles- to

rules-based approaches. As a result, some respondents believed that as the audit approach becomes more

prescriptive, compliance exercises rather than the use of professional judgment would be prompted. This would

significantly affect the effectiveness of the audit process and audit quality in consequence. In response to that

issue, 15 respondents took the view that regulators should promote and support the principles-based audit

approach in their initiatives and projects in the audit arena to ensure high audit quality. Overall, one pertinent

issue that emerged from the analysis concerning the effectiveness of the audit process is in relation to theimpact of various factors such as regulation, audit client, AC, individual auditors, and firms’ policies and

procedures on the effectiveness of the audit process to achieve audit quality.

The Reliability and Usefulness of the Audit Report

The FRC identified reliability and usefulness of audit reporting that command confidence as one of the

key drivers of audit quality, which attracted many comments from the institutional investors. Analysis shows

that the respondents generally viewed that the concept of audit quality is closely linked to the accuracy and

credibility of the audit opinion that enhances quality of financial statements. As such, they suggested that the




audit report should be accurate and the auditors should be seen as an independent professional entity. For

example, “The value of the audit opinion is strongly linked to the usefulness of the accounts” (Coal Pension

Trustees, 2007, p. 2).

Some other comments put forward by the commentators concerning factors affecting confidence in audit

opinions include greater information from audit firms regarding their process and policies and reputation of

audit firm and audit profession. In comparison, some of the factors identified which could reduce confidence in

audit opinion are related to the format of the audit report (length and legalistic wording) and prescriptive audit

approach in audit.

Other Factors Affecting Audit Quality

On the whole, the respondents supported the significant contributions made by the management of the

audit client and ACs to audit quality. The professional bodies pointed out the important role of the audit client

for audit performance. Similarly, audit firms identified that the culture of the audited company and the skills

and personal qualities of its board and executive management could enhance the effectiveness of the audit

process. Respondents also recognized the important role and responsibilities of the members of ACs for auditquality. There was a consensus among the audit firms concerning the important role of AC in the auditing and

financial reporting process. Ernst and Young (2003) noted that based on their experience, the ACs had become

stronger and more questioning of what auditors do. The audit firm respondents acknowledged the increasing

quality of communication between them and ACs. They also believe that detailed evaluation of audit guidelines

would help ACs to function more effectively. On the other hand, investors requested more disclosure about the

work performed by ACs that enhances users’ confidence in audit quality. These were illustrated by the

following quotations: “The culture of the audited company and the skills and personal qualities of its board and

executive management are very important drivers of audit quality” (Ernst and Young, 2007, p. 3).

“The responsibilities ACs have undertaken in relation to the audit process can give confidence toshareholders that the auditor/client relationship is sufficiently independent and that sufficient attention is being

paid to audit quality” (Deloitte, 2007, p. 2).

Prior research shows mixed results concerning the effect of ACs on audit quality (Carcello & Neal, 2000;

Abbott, Parker, Peters, & Raghunandan, 2003a, 2003b; Lee & Mande, 2005; Piot & Janin, 2007). Further, these

archival studies failed to document the processes involved between the auditors and ACs members and its

impact on audit quality. Hence, this provides an opportunity to investigate further how ACs’ understanding of

the concept of audit quality influences their operation and process and its effect on audit function and audit

quality in the new auditing environment.

In general, the respondents expressed a high degree of support for the initiative and the audit quality

framework proposed by the FRC. In particular, almost all respondents were in favor of the attempt of the FRCto recognize a broad set of significant issues relating to audit quality through identification of drivers and

threats that could enhance and undermine the audit quality. While acknowledging the positive contribution of

the discussion paper, some respondents expressed adverse comments. For example, a few respondents referred

to the lack of relevant and empirical evidence to support the assertions stated in the discussion paper. Three of

the audit firm respondents had significant criticisms of some of the threats to audit quality identified in the

discussion paper, which were unsubstantiated. The discussion paper failed to recognize other critical drivers,

such as auditor independence and audit regulation.




“Qualities of independence in the audit and the auditor are crucial, but this is a dimension that receives

insufficient attention in the paper” (Association of British Insurers, 2007, p. 1).

Overall, most of the respondents welcomed the initiative and project in the audit arena in the name of

understanding and enhancing audit quality. However, there are limited comments from the respondents that

provided any detailed analytical assessment of the concept and definition of audit quality. Only two of the

respondents to the discussion paper sought clarity about the definition of audit quality. For example, the

corporate respondent, the Hundred Group of Finance Directors suggested that audit market constituents such as

auditors and ACs should define more clearly the meaning of audit quality by providing qualitative and

quantitative measures that could be used to assess the quality of the audit. Another respondent, the ICAEW,

raised concern about the imbalance in the definition of audit quality and its drivers as proposed by the FRC.

Issues relating to the effect of changes in audit regulation were significant features of almost all responses

to the discussion paper. Although the changes are aimed at enhancing audit quality, several of the respondents

expressed adverse opinions. Thirteen respondents mentioned resource concerns arising from the current audit

regulations. For instance, five of the audit firms referred to the increased time and cost needed to fulfill variousregulatory requirements. Increased oversight activities have caused additional workload for the audit firms,

because more staff are needed to spend time in meeting the regulatory requirements. Analysis suggests that

staffing and cost become major concerns to firms. In light of the ongoing debate about the benefits of the new

regulation, it seems worth investigating the costs and benefits of the oversight function to audit firms and

overall audit quality.

Conclusions

The study presents a snapshot of a small part of the audit quality debate, through the eyes of those who

responded to the discussion paper. This study did not intend to draw specific generalized conclusions about the

research topic from these responses; instead, it is necessary to provide an additional information source to drawout areas that are potentially relevant for further investigation and that can enhance our knowledge about audit

quality in practice.

First, while questions of how audit quality is defined and understood by professional practitioners are

indeed important (Carcello et al., 1992; Duff, 2004), analysis of the responses draws attention to the lack of a

practitioners’ construct of the meaning of audit quality. The meaning of the term audit quality remains implicit

rather than clearly articulated. The practitioners said relatively little about the “technical” definition of audit

quality in terms of what it means. They discussed more on drivers of audit quality, such as expertise, skills,

professional judgment, and culture of the audit firm. While there may be advantages to understand the term

audit quality based on its drivers and threats, the relationship between audit quality and the factors in the newaudit environment remains unclear.

Second, as illustrated in this study, the concept of audit quality develops dynamically and is influenced by

many factors which are prevalent in the auditing setting. The process and impact of regulatory development

may be significant, so are the economic environment and the influence of interactions among different parties

(such as AC, regulator, and audit client) with particular roles in the auditing system.

Overall, this paper demonstrates the value of understanding of how internal and external factors in

auditing environment might influence quality delivered in practice. One of the most significant findings

emerged from this study is that audit quality has to be seen in the context of a range of interwoven laws,




regulations and guidance, cooperation of executive management, participation of AC, and the effectiveness of

the audit firm’s procedures and policies, all of which promote high audit quality. The results of this

investigation show that audit quality is influenced by various elements within and outside the audit firm.

However, the overall impact that these various elements have on audit quality is subjected to further

examination.

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